Can rent be claimed as an administration expense by landlords?

As a landlord, you may try to claim rent as an administration expense, but can you legally do this?

Ford (Administrator), in the matter of The PAS Group Limited (Administrators Appointed) v Scentre Management Limited [2020] FCA 1023

In this recent Federal Court decision, the administrators of The PAS Group Limited (the administrators) sought a declaration by the Court that rent and any other amounts payable under any lease agreement involving PAS Group Limited and its subsidiaries (PAS Group) constitutes an unsecured debt or claim, and is not entitled to priority over other debts or claims as an expense of the PAS Companies' administrations pursuant to section 556(1) of the Corporations Act 2001 (Cth) (the Act).

Background

PAS Group Limited is an Australian-based fashion group that leases a total of 166 premises in Australia and New Zealand. The defendant in this case was Scentre Management Limited (Scentre) as a representative of the interests of all landlord creditors of PAS Group. Scentre is the largest Lessor of premises to the PAS Group, leasing 26 premises in total. PAS Group did not pay rent between 29 May 2020 to 22 June 2020, which is referred to as the standstill period.

Scentre opposed the declaration being sought by PAS Group, and argued that the rent incurred during the standstill period would be an expense properly incurred in carrying on the business of PAS Group, and should be paid in priority to all other unsecured debts or claims.

Section 556(1) of the Act states that in the winding up of a company, certain debts and claims must be paid in priority to all other unsecured debts and claims. This includes expenses properly incurred by a relevant authority in preserving, realising, or getting in property of the company, or in carrying on the company's business.

The administrators of PAS Group submitted that in respect of the 26 premises leased by Scentre to PAS Group, gross revenue of $944,076 was generated during the standstill period and the total rent payable in that period amounted to $382,396, therefore, the total revenue exceeded the rent payable by $561,680.

The administrator's argument on if rent can be claimed as an Administration Expense

The administrators argued firstly that a Lessor's claim for rent under a pre-appointment lease is an ordinary unsecured claim against the company. They contended that since administrators are only personally liable for amounts payable after the standstill period has ended, the Lessor's claim in respect of the standstill period will be an ordinary unsecured claim.

The administrators also argued that since the voluntary administration scheme was intended to balance competing equities, if rent were to be treated as an administration expense, it would constitute a 'super priority' inconsistent with the voluntary administration scheme. They also cited various sections of the Act as an alternative to reliance on the aforementioned section 556(1); however, the Court decided that those provisions were largely irrelevant in the circumstances.

The Court did not accept the administrator's submissions. It held that it is a well-established proposition (dating back to the 1870s) that rent payable is regarded as an 'expense incurred in carrying on the business'. Whether the outstanding rent is classified as a debt or priority claim under the Act is to be determined with reference to the usual principles from the case of Lundy Granite,[1] in conjunction with section 556 of the Act. The Lundy Granite principle states that where an administrator elects to have the company continue in occupation of leased premises for the purposes of administration, the rent is payable as an expense of the administration.

The reason for this principle is to prevent an administrator from using the leased premises for the benefit of the company at essentially no cost to the company. The principle is also not discretionary - if an administrator allows a company to use premises for the purpose of administration, then they are deemed to be liable for the expenses incurred.

The Court's decision on Administration Expense

In this case, the Court made it clear that the leased properties were used in carrying on the companies' business, as the administrators had made the decision to continue trading in an effort to maximise the prospects of PAS Group's ability to avoid liquidation. Further, by continuing to trade and use the leased premises, PAS Group generated over $7 million in revenue in the approximately three week standstill period.

Therefore, the Court decided that the unpaid rent that was incurred during the standstill period is to be regarded as an expense properly incurred in carrying on the business of the PAS Group within the meaning of section 556(1) of the Act. The administrators failed to justify why Scentre would be deprived of their priority position in receiving the unpaid rent.

The Court concluded by stating 'common sense and ordinary justice require the Court to see that the landlord is paid'.

This case therefore serves as a useful reminder that in the event of a tenant entering into administration but continuing to use and occupy leased premises, landlords may be able to claim unpaid rent with a priority position over other unsecured debts and claims.

[1] Re Lundy Granite Co; Ex parte Heavan (1871) LR 6 Ch App 462.